Finance Chapters 13-14 Multiple Choice

b. False

A poison pill is also known as a corporate restructuring. a. True b. False

e. If a firm's stock price is quite high relative to most stocks—say $500 per share—then it can declare a stock split of say 10-for-1 so as to bring the price down to something close to $50. Moreover, if the price is relatively low—say $2 per share—then it can declare a "reverse split" of say 1-for-25 so as to bring the price up to somewhere around $50 per share.

11. Which of the following statements is CORRECT? a. When firms are deciding on the size of stock splits—say whether to declare a 2-for-1 split or a 3-for-1 split, it is best to declare the smaller one, in this case the 2-for-1 split, because then the after-split price will be higher than if the 3-for-1 split had been used. b. Back before the SEC was created in the 1930s, companies would declare reverse splits in order to boost their stock prices. However, this was determined to be a deceptive practice, and it is illegal today. c. Stock splits create more administrative problems for investors than stock dividends, especially determining the tax basis of their shares when they decide to sell them, so today stock dividends are used far more often than stock splits. d. When a company declares a stock split, the price of the stock typically declines—by about 50% after a 2-for-1 split—and this necessarily reduces the total market value of the equity. e. If a firm's stock price is quite high relative to most stocks—say $500 per share—then it can declare a stock split of say 10-for-1 so as to bring the price down to something close to $50. Moreover, if the price is relatively low—say $2 per share—then it can declare a "reverse split" of say 1-for-25 so as to bring the price up to somewhere around $50 per share.

e. Stockholders pay no income tax on dividends if the dividends are used to purchase stock through a dividend reinvestment plan.

14. Which of the following statements is NOT CORRECT? a. Stock repurchases can be used by a firm as part of a plan to change its capital structure. b. After a 3-for-1 stock split, a company's price per share should fall, but the number of shares outstanding will rise. c. Investors can interpret a stock repurchase program as a signal that the firm's managers believe the stock is undervalued. d. Companies can repurchase shares to distribute large inflows of cash, say from the sale of a division, to stockholders without paying cash dividends. e. Stockholders pay no income tax on dividends if the dividends are used to purchase stock through a dividend reinvestment plan.

a. True

ESOPs were originally designed to help improve worker productivity, but today they are also used to help prevent hostile takeovers. a. True b. False

b. Firm M probably has a higher dividend payout ratio than Firm N.

Firm M is a mature firm in a mature industry. Its annual net income and net cash flows are both consistently high and stable. However, M's growth prospects are quite limited, so its capital budget is small relative to its net income. Firm N is a relatively new firm in a new and growing industry. Its markets and products have not stabilized, so its annual operating income fluctuates considerably. However, N has substantial growth opportunities, and its capital budget is expected to be large relative to its net income for the foreseeable future. Which of the following statements is CORRECT? a. Firm M probably has a lower debt ratio than Firm N. b. Firm M probably has a higher dividend payout ratio than Firm N. c. If the corporate tax rate increases, the debt ratio of both firms is likely to decline. d. The two firms are equally likely to pay high dividends. e. Firm N is likely to have a clientele of shareholders who want to receive consistent, stable dividend income.

d. investors view dividends as being less risky than potential future capital gains.

Myron Gordon and John Lintner believe that the required return on equity increases as the dividend payout ratio is decreased. Their argument is based on the assumption that a. investors are indifferent between dividends and capital gains. b. investors require that the dividend yield and capital gains yield equal a constant. c. capital gains are taxed at a higher rate than dividends. d. investors view dividends as being less risky than potential future capital gains. e. investors value a dollar of expected capital gains more highly than a dollar of expected dividends because of the lower tax rate on capital gains.

b. False

The CEO of D'Amico Motors has been granted some stock options that have provisions similar to most other executive stock options. If D'Amico's stock underperforms the market, these options will necessarily be worthless. a. True b. False

a. The firm's net income increases.

Trenton Publishing follows a strict residual dividend policy. All else equal, which of the following factors would be most likely to lead to an increase in the firm's dividend per share? a. The firm's net income increases. b. The company increases the percentage of equity in its target capital structure. c. The number of profitable potential projects increases. d. Congress lowers the tax rate on capital gains. The remainder of the tax code is not changed. e. Earnings are unchanged, but the firm issues new shares of common stock.

e. Begin a new-stock dividend reinvestment plan.

Which of the following actions will best enable a company to raise additional equity capital? a. Refund long-term debt with lower cost short-term debt. b. Declare a stock split. c. Begin an open-market purchase dividend reinvestment plan. d. Initiate a stock repurchase program. e. Begin a new-stock dividend reinvestment plan.

a. Increasing the expected growth rate of sales.

Which of the following does NOT always increase a company's market value? a. Increasing the expected growth rate of sales. b. Increasing the expected operating profitability (NOPAT/Sales). c. Decreasing the capital requirements (Capital/Sales). d. Decreasing the weighted average cost of capital. e. Increasing the expected rate of return on invested capital.

a. Abnormally high executive compensation.

Which of the following is NOT normally regarded as being a barrier to hostile takeovers? a. Abnormally high executive compensation. b. Targeted share repurchases. c. Shareholder rights provisions. d. Restricted voting rights. e. Poison pills.

c. To make it easier to grant stock options to employees.

Which of the following is NOT normally regarded as being a good reason to establish an ESOP? a. To increase worker productivity. b. To enable the firm to borrow at a below-market interest rate. c. To make it easier to grant stock options to employees. d. To help prevent a hostile takeover. e. To help retain valued employees.

e. The clientele effect suggests that companies should follow a stable dividend policy.

Which of the following statements about dividend policies is CORRECT? a. Modigliani and Miller argue that investors prefer dividends to capital gains because dividends are more certain than capital gains. They call this the "bird-in-the hand" effect. b. One reason that companies tend to avoid stock repurchases is that dividend payments are taxed at a lower rate than gains on stock repurchases. c. One advantage of dividend reinvestment plans is that they allow shareholders to avoid paying taxes on the dividends that they choose to reinvest. d. One key advantage of a residual dividend policy is that it enables a company to follow a stable dividend policy. e. The clientele effect suggests that companies should follow a stable dividend policy.

c. Very often, a company's stock price will rise when it announces that it plans to commence a share repurchase program. Such an announcement could lead to a stock price decline, but this does not normally happen.

Which of the following statements is CORRECT? a. If a company has a 2-for-1 stock split, its stock price should roughly double. b. Capital gains earned in a share repurchase are taxed less favorably than dividends; this explains why companies typically pay dividends and avoid share repurchases. c. Very often, a company's stock price will rise when it announces that it plans to commence a share repurchase program. Such an announcement could lead to a stock price decline, but this does not normally happen. d. Stock repurchases increase the number of outstanding shares. e. The clientele effect is the best explanation for why companies tend to vary their dividend payments from quarter to quarter.

d. Large stock repurchases financed by debt tend to increase earnings per share, but they also increase the firm's financial risk.

Which of the following statements is CORRECT? a. The tax code encourages companies to pay dividends rather than retain earnings. b. If a company uses the residual dividend model to determine its dividend payments, dividends payout will tend to increase whenever its profitable investment opportunities increase. c. The stronger management thinks the clientele effect is, the more likely the firm is to adopt a strict version of the residual dividend model. d. Large stock repurchases financed by debt tend to increase earnings per share, but they also increase the firm's financial risk. e. A dollar paid out to repurchase stock is taxed at the same rate as a dollar paid out in dividends. Thus, both companies and investors are indifferent between distributing cash through dividends and stock repurchase programs. 7. Which of the following statement

e. Stock repurchases make the most sense at times when a company believes its stock is undervalued.

Which of the following statements is CORRECT? a. Firms with a lot of good investment opportunities and a relatively small amount of cash tend to have above average payout ratios. b. One advantage of the residual dividend policy is that it leads to a stable dividend payout, which investors like. c. An increase in the stock price when a company decreases its dividend is consistent with signaling theory as postulated by MM. d. If the "clientele effect" is correct, then for a company whose earnings fluctuate, a policy of paying a constant percentage of net income will probably maximize the stock price. e. Stock repurchases make the most sense at times when a company believes its stock is undervalued.

a. If a firm follows the residual dividend policy, then a sudden increase in the number of profitable projects is likely to reduce the firm's dividend payout.

Which of the following statements is CORRECT? a. If a firm follows the residual dividend policy, then a sudden increase in the number of profitable projects is likely to reduce the firm's dividend payout. b. The clientele effect can explain why so many firms change their dividend policies so often. c. One advantage of adopting the residual dividend policy is that this policy makes it easier for corporations to develop a specific and well-identified dividend clientele. d. New-stock dividend reinvestment plans are similar to stock dividends because they both increase the number of shares outstanding but don't change the firm's total amount of book equity. e. Investors who receive stock dividends must pay taxes on the value of the new shares in the year the stock dividends are received.

a. If a firm repurchases some of its stock in the open market, then shareholders who sell their stock for more than they paid for it will be subject to capital gains taxes.

Which of the following statements is CORRECT? a. If a firm repurchases some of its stock in the open market, then shareholders who sell their stock for more than they paid for it will be subject to capital gains taxes. b. An open-market dividend reinvestment plan will be most attractive to companies that need new equity and would otherwise have to issue additional shares of common stock through investment bankers. c. Stock repurchases tend to reduce financial leverage. d. If a company declares a 2-for-1 stock split, its stock price should roughly double. e. One advantage of adopting the residual dividend policy is that this makes it easier for corporations to meet the requirements of Modigliani and Miller's dividend clientele theory.

b. If a company has an established clientele of investors who prefer a high dividend payout, and if management wants to keep stockholders happy, it should not follow the strict residual dividend policy.

Which of the following statements is CORRECT? a. One advantage of dividend reinvestment plans is that they enable investors to avoid paying taxes on the dividends they receive. b. If a company has an established clientele of investors who prefer a high dividend payout, and if management wants to keep stockholders happy, it should not follow the strict residual dividend policy. c. If a firm follows a strict residual dividend policy, then, holding all else constant, its dividend payout ratio will tend to rise whenever the firm's investment opportunities improve. d. If Congress eliminates taxes on capital gains but leaves the personal tax rate on dividends unchanged, this would motivate companies to increase their dividend payout ratios. e. Despite its drawbacks, following the residual dividend policy will tend to stabilize actual cash dividends, and this will make it easier for firms to attract a clientele that prefers high dividends, such as retirees.

c. Stock repurchases can be used by a firm that wants to increase its debt ratio.

Which of the following statements is CORRECT? a. One disadvantage of dividend reinvestment plans is that they increase transactions costs for investors who want to increase their ownership in the company. b. One advantage of dividend reinvestment plans is that they enable investors to postpone paying taxes on the dividends credited to their account. c. Stock repurchases can be used by a firm that wants to increase its debt ratio. d. Stock repurchases make sense if a company expects to have a lot of profitable new projects to fund over the next few years, provided investors are aware of these investment opportunities. e. One advantage of an open market dividend reinvestment plan is that it provides new equity capital and increases the shares outstanding.

d. If a company wants to raise new equity capital rather steadily over time, a new stock dividend reinvestment plan would make sense. However, if the firm does not want or need new equity, then an open market purchase dividend reinvestment plan would probably make more sense.

Which of the following statements is CORRECT? a. Under the tax laws as they existed in 2008, a dollar received for repurchased stock must be taxed at the same rate as a dollar received as dividends. b. One nice feature of dividend reinvestment plans (DRIPs) is that they reduce the taxes investors would have to pay if they received cash dividends. c. Empirical research indicates that, in general, companies send a negative signal to the marketplace when they announce an increase in the dividend, and as a result share prices fall when dividend increases are announced. The reason is that investors interpret the increase as a signal that the firm has relatively few good investment opportunities. d. If a company wants to raise new equity capital rather steadily over time, a new stock dividend reinvestment plan would make sense. However, if the firm does not want or need new equity, then an open market purchase dividend reinvestment plan would probably make more sense. e. Dividend reinvestment plans have not caught on in most industries, and today about 99% of all companies with DRIPs are utilities.

b. The corporate valuation model discounts free cash flows by the required return on equity.

Which of the following statements is NOT CORRECT? a. The corporate valuation model can be used both for companies that pay dividends and those that do not pay dividends. b. The corporate valuation model discounts free cash flows by the required return on equity. c. The corporate valuation model can be used to find the value of a division. d. An important step in applying the corporate valuation model is forecasting the firm's pro forma financial statements. e. Free cash flows are assumed to grow at a constant rate beyond a specified date in order to find the horizon, or terminal, value